Differences in U.S. stocks, emerging markets

Question: Why are U.S. stocks rising while emerging-market stocks are falling? What do such divergences mean for future stock prices around the world?

Answer: The U.S. stock market has been surging to new highs this year, while emerging market stock indexes are down and near two-year lows. With the global economy continuing an overall recovery, how can stock-market performances be so divergent? Such differences are all the more puzzling since traditional valuation measures don’t suggest that emerging-market equities were pricey a year ago, compared with U.S. equities.

Emerging market stocks offered much better valuations, dividend yields and earnings growth rates in the late 1990s. Emerging-market stocks did much better than most, including U.S. stocks from the late-1990s peak, until recently.

But times have changed for emerging stock markets, compared with the U.S. stock market. Excess performance doesn’t last forever, and market leadership changes. Growth rates have slowed in many emerging economies, and falling commodity prices also have cut into the profitability of such firms in those markets.

Now, this is not to say that the recent trend of U.S. stocks outperforming emerging market stocks is going to continue for many years to come. Emerging-market equities are again offering more favorable valuations.

During periods of general economic expansion or contraction (recessions), it’s easy to think that all or nearly all stock markets are moving in tandem. And, for sure, many or even most markets may be moving in tandem, but even those that are can have widely varying performances.

And some markets fall while most others rise, and vice-versa.

Consider Japan’s stock market, which I’ve written about extensively, which fell tremendously during the 1990s — a period when most countries experienced rapidly rising stock prices.

Sometimes divergences go to extremes and present opportunities for astute and informed investors. In the late 1990s, U.S. stock valuations, especially in the technology sector, were being stretched and were high by historic standards, while emerging-market stocks were selling at historically low valuations. Investing extra money in emerging markets at such a time and possibly selling some U.S. stock funds to invest more in emerging markets made good sense.

Looking at today’s stock markets around the globe, we may be seeing another buying opportunity for emerging markets, but it’s not as compelling as the one that happened in the late 1990s.

Be diversified in stocks globally, and invest in low-cost index funds and actively managed funds run by leading fund managers.

Don’t try to pick specific country funds — use broadly diversified foreign stock funds when investing outside the U.S.

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